An extremist, not a fanatic

June 29, 2014

Fiscal idiotarianism

Politically, if not intellectually, the austerians have won. As Aditya says, both main parties are commited to "fiscal impossibilism". The IPPR's Condition of Britain report, for example, takes ongoing austerity for granted.

This raises a puzzle. The Bank of England has consistently said that the decision on when or whether to tighten monetary policy will be "data driven". Although some MPs have trouble grasping this simple concept, it is surely sensible; policy must be set according to the facts. Why then, should this not also be true of fiscal policy?

Let me deepen the question. There is a risk that the euro area could fall into a Japan-style lost decade of stagnation. This would gravely weaken the case for tighter fiscal policy. If a market which accounts for two-fifths of our exports stagnates, then tax revenues will falter and attempts to swiftly reduce the deficit would further depress the economy and might prove counter-productive.

To put this another way, think about financial balances. One aspect of euro stagnation would be that the region will continue to run a big current account surplus (pdf); this would be the counterpart of tight fiscal policy in the region, plus weak capital spending. If our biggest trading partner runs a current account surplus, we will probably have to continue to run a current account deficit. The counterpart to this is that some domestic sector must also run a deficit. But who? The OBR foresees companies continuing to run a surplus. This means that the government can return to balance if and only if households become huge net borrowers. But what if this doesn't happen - say because tighter macroprudential regulation prevents it or because households prefer to reduce debt? In this case, the government will have to run a deficit, possibly a big one. Attempts to bring even the current budget into balance would run into the paradox of thrift and simply depress demand.

Granted, all this is only a risk not a certainty. But sensible policy must be set according to risks and not merely according to a central case forecast.

Why then, don't politicians do what Carney does, and say that policy will be data-driven?

It's not good enough to argue that counter-cyclical policy should be done by monetary policy alone. This might be tricky if we are at or near the zero bound - or at least, if MPs think large-scale quantitative easing is the best counter-cyclical policy they should say so, and explain why.

You might think the answer lies in the word "credibility". It does - but not in credibility with financial markets; the fact that long-term real yields are negative tells us that, for practical purposes, this exists. Instead, the two parties are competing for "credibility" with a media and public that has fallen for idiotarian talk that the public finances are the nation's credit card. And we get the governments we deserve.

Comments

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Chris,

You’ve identified the problem beautifully, but you haven’t given a very clear answer. That’s the answer to the question: “Why then, don't politicians do what Carney does, and say that policy will be data-driven?”

The answer is that the economic illiterates in Westminster and the Treasury think that more fiscal stimulus involves more national debt. And the word “debt” has negative emotional overtones.

Paul Krugman actually said that Kenneth Rogoff’s concerns about debt were driven by emotion, or words to that effect.

In fact, as Keynes pointed out, extra fiscal stimulus can be funded by borrowing OR PRINTING money. Thus there’s no need to increase the debt.

Of course whenever the words “print” and “money” appear in the same sentence, another lot of economic illiterates appear out of the woodwork chanting “inflation”. But they’ve been rather confounded by the ASTRONOMIC increase in central bank created money now sloshing around thanks to QE combined with an absence of inflation.

When one talks of inflation, one needs to talk of deflation and standard of living as well. In the US there has been inflation every year since...well, since they began measuring it. Yet since the 1970's this "inflation" has eluded working male wage workers. It doesn't matter if the price level goes up and you don't get raises, or the price level doesn't go up and you get less pay - the effect is the same.

If the FED money creation keeps the assets the rich own from any decrease in price (letting the rich bankers keep their fraud induced house price increases during the housing bubble) - who does that help and who does that hurt?